Question
Consider a firm that might either be worth $105 million (up state) or $90 million (down state) next year. Assume that the prevailing risk-free rate
Consider a firm that might either be worth $105 million (up state) or $90 million (down state) next year. Assume that the prevailing risk-free rate is 2% per year. Further assume that the company is valued at $92 million today.
a) What is the implied price of the up-state asset today---i.e., an asset that pays out $1 in the up state next year and $0 in the down state next year (units: dollars)?
b) What is the implied price of the down-state asset today---i.e., an asset that pays out $0 in the up state next year and $1 in the down state next year (units: dollars)?
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